INVESTMENT DECISION

Investment Decision



Investment Decision

Section A: Introduction to the topic

A paradigm widely considered as how prices react in speculative markets is the efficient market hypothesis (EMH). This theory is based upon the research of Fama which was conducted in the year that “A market in which prices always fully reflect available information is called efficient”. His theory has been challenged in recent years by empirical evidence that technical trading strategies generate economic profits. According to Fox (2009) even Fama has changed his stance on EMH, “The creator of the efficient market hypothesis no longer believed that prices were right, while some of the efficient market's fiercest critics found them selves teaching in the classroom prices were right. Many academics still subscribe to this theory of efficient capital markets or efficient market hypothesis.

The trading strategies used by individual investors and portfolio managers may not always follow traditional empirical research. Two of the most commonly used trading strategies used for picking individual stocks are fundamental and technical analysis. These two approaches, generally used in predicting stock price movement, are both firmly rejected as profitable by the EMH. Technical analysis is the use of price charts and volume analysis to pick stocks. Repetitive chart patterns are used in technical analysis to formulate trading decisions. Fundamental analysis, on the other hand, is determining the value of a company using factors such as dividends, risk, interest rates, and other fundamental factors. Therefore, this is the overall theory of Efficient Market Hypothesis.

Section B: Review of the Previous Studies

The Subsequent research by Fama (1970) led to the introduction of three subsets of EMH called the weak-form, semi-strong form, and strong-form. The semi-strong form being the most widely accepted which supposes that the price reflects all available public information. This leads to one controversial assumption that public information is available to all investors. Bloomfield (2002) suggested that information is not without cost and that many small investors do not have the time or money to collect certain information.

Public information is disseminated through various outlets; however, this data may not represent relevant ratios or statistics that reflect how the business is doing in certain segments. A press release may describe what a company wishes to take place and give details of company strategies; however, convincing analysis of the data must be researched. Without knowing relevant material s in an income statement or balance sheet, a novice investor is left trading on company propaganda. Large institutions such as mutual funds and hedge funds analyze available data and are willing to pay their own analysts to gather information from company leaders. They have the economic advantage compared to individual investors. Bloomfield (2002) has formed his own theory called the incomplete revelation hypothesis (IRH), which supposes that the markets are not efficient and that information may or may not move a stock price due to how the information is revealed. Those individuals willing to invest in the acquisition of data have an edge over the small investor who ...